The 27 countries of the EU will hold a summit on December 9 in what has been called the last chance to solve the eurozone financial crisis. However, in politics, ‘last chances’ are rarely final. The eurozone has already gone through at least four rescue packages, initially hailed as final solutions but later exposed as unsustainable fudges.
History may repeat itself at the December 9 summit. It could produce another package that enthuses optimists temporarily. Yet, this optimism could soon be eroded by continuing doubts on the ability of European politicians to deliver some sort of plausible fiscal union.
Angela Merkel of Germany visualises institutionalised austerity as the foundation of the new fiscal agreement, with strict fiscal rules enforced by an independent institution such as the European Court of Justice.
Any such institution charged with implementing sanctions would need a formal mandate to override national finance ministers. But this would imply a politically impossible surrender of sovereignty by other members. The contradiction may be papered over by noble expressions of intent at the summit, but will not go away.
Institutionalised austerity looks certain to sink Europe into serious recession in 2012, and it may well drag down the world economy along with it. This is a pity: economic news from the US is increasingly positive, and that country seems on the verge of finally coming out of its four-year stagnation.
The unemployment rate is down, the Thanksgiving season witnessed record increases in retail sales, and both GDP and industrial production have picked up. But the fallout from Europe could nip this recovery in the bud.
There is one solution. If only the European Central Bank (ECB) agrees to print money in unlimited quantities to support the bonds of eurozone states – something Ben Bernanke would do without a second thought in the US – then the euro crisis would end. This would cause inflation, but would guarantee that all sovereign debt would be repaid in full.
Alas, the ECB has a single mandate to produce price stability, unlike the US Fed which is also mandated to produce full employment and economic growth along with price stability.
The ECB apart, Merkel will not countenance an ECB that simply prints money and lets errant states like Greece off the hook. Indeed, unlimited ECB support for country bonds would probably violatethe EU treaty and provisions of the German constitutional court.
One proposed fudge is for the ECB to lend money to the International Monetary Fund (IMF), which would then give big loans with stiff conditionality to individual states. Whether this dodge will pass legal scrutiny is uncertain. Besides, the transmission of cash to the deficit countries via the bureaucratic IMF will be slow and limited, and so may not suffice to prevent a snowballing bank crisis that hits the sovereign bond markets too.
The problem began with the creation of a monetary union between 17 of the 27 EU members, who gave up their national currencies and adopted the euro. Even at the time, economists like Martin Feldstein warned that a monetary union without a fiscal union would fail.
The US, for instance, has 50 states in a common monetary and fiscal union. They all use the same currency, so if some states turn uncompetitive, they cannot devalue to get out of their structural disadvantage.
But being part of a fiscal union, taxes from the competitive states will automatically meet additional welfare spending in the uncompetitive states, and nobody views this as unfair.
However, the eurozone is not a single nation: it represents countries that have adopted a common currency and central bank, but do not have a fiscal union. Money does not automatically flow from countries with surpluses to those with fiscal deficits. So, while the eurozone as a whole has a very manageable fiscal deficit of around 4% of GDP, the prudent northern members run surpluses while the southern members have large deficits.
For maybe a decade, Greece and Portugal have been uncompetitive in relation to Germany or Holland, yet all have the same currency, and the weaker members cannot devalue to regain competitiveness. Instead, the only course is ‘internal devaluation’ through continuing cuts in real wages and welfare benefits, which are utterly corrosive and almost certainly unsustainable in a democracy.
This buttresses the case for breaking up the eurozone. Either a few laggards like Greece can exit, or the zone can split into two currency zones, one for stronger northern countries and another for weaker southern ones.
However, European politicians absolutely refuse at this stage to look at a eurozone split or collapse. They believe that the exit of a single member would lead to contagion and the exit of one country after another. So, they have resolved to hold firm.
Yet, this leaves unaddressed the problem of how to keep highly competitive countries like Germany and Holland inthe same currency union as uncompetitive ones like Greece and Portugal.
Talk of staying together will have to be backed by an agreement on the terms under which surplus states will always agree to bail out deficit ones. However, voters in the north are against constant bailouts, and voters in the south resent what they see as northern arrogance and bullying. Many types of fudge are possible to overcome the problem temporarily, but no lasting solution is in sight.